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Square Inc.’s announcement over the weekend that it is making digital gift cards available for its base of mostly small merchants heralded the San Francisco startup’s entry into what is turning into a hot market, particularly with the onset of the holiday-shopping season.

Square, which in recent months revamped its merchant pricing and agreed to process transactions for coffee emporium Starbucks Corp., will now compete with merchant acquirers that have been selling gift card programs to merchants for years. Its new program will allow consumers to send a digital card to anyone via e-mail. Recipients can store the electronic card in the Square Wallet app or, for those with Apple Inc.’s latest operating system, in Apple’s Passbook wallet owing to an integration also announced on the weekend. Users can redeem the card via barcode scanning directly from their phones or by printing out the code and taking it to the store. Also, Square Wallet, which opens a tab as users walk in the store, allows cardholders to redeem the card by giving their name.

It remained unclear late on Monday whether merchants must conclude a separate agreement with Square to participate in the program. Square did not respond to questions from Digital Transactions News. Assuming Square’s pricing for other transactions applies, gift card sales will cost merchants 2.75%. Under a new pricing policy Square announced in August, merchants can process up to $250,000 per year for a flat fee of $275 per month.

For consumers, digital gift cards are quick and convenient, and offer the chance to postpone, for example, Christmas gift giving until virtually the last minute. For merchants, they represent a far less expensive alternative to plastic cards. But market size is another matter. While growing, the segment will account for $330 million in loads in November and December, about 0.8% of the overall closed-loop gift card market over those two months, according to Mercator Advisory Group, Maynard, Mass. “The short version is, they’re not super-exciting in terms of volume,” says Mercator analyst Ben Jackson.

That could change soon. Companies that specialize in digital cards say they are about to tap a gold mine. “We’ve found that no one’s waiting any more, everyone’s trying to figure out how to get into this space,” says Tom Niedbalski, senior vice president of business development at Transaction Wireless, a San Diego company that provides digital gift cards for chains including Buffalo Wild Wings, Finish Line, and Land’s End. The company added 100 retail brands over the past year and now processes for 150, Niedbalski says. Since Transaction Wireless also sells plastic gift cards, it has tracked consumer preference. “We’re seeing at least 60% gravitating to digital cards,” says Niedbalski.

The biggest test of this preference may come in Target Corp. stores. The retailing giant has started offering digital Target gift cards at the same displays where it sells the plastic versions. To send a digital card, consumers use their smart phone to scan a barcode at the display. Mercator’s Jackson says this is the first time he has seen side-by-side marketing of the two types of card. The test will be whether virtual cards will “have an edge for somebody who’s shopping for plastic where that plastic is instantly grabbable,” he notes.

Still, while the market may be on the verge of a boom, it could hold disadvantages for Square. While digital cards may save money for small businesses looking to squeeze expenses, many of these merchants may still prefer physical plastic, Jackson says. And the volume potential from more than 200,000 Square businesses may not in the end total to an impressive number. “It’s cool to those of us in the payments business, but I’m not sure anybody’s going to get all that excited about it,” says Jackson.

Rick Oglesby, a senior analyst at Boston-based Aite Group who follows mobile payments, agrees, but adds there could be a larger significance to Square’s move into the market. “It won’t show up as huge number, but it’s a good demonstration of what cloud-based services can do,” he says. “There’s 200,000 merchants out there that don’t have to do anything [to participate].”